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Workers are Pissed

In Germany workers are pissed
As unions there try to insist
A six percent rise
In wages is wise
If not, strikes they may soon enlist

The market is watching and sees
This outcome, Herr Draghi should please
If it comes to pass
Inflation, at last,
Might rise hinting at no more ease

Meanwhile Janet’s reign is soon done
For stock markets it’s been great fun
Will Powell (called Jay)
Take the punch bowl away?
And if so, will the dollar then run?

The dollar is back under a bit of pressure this morning as equity markets in Europe try to shake off the past two days declines. Asian markets had no such luck, falling for a third consecutive session, but thus far Europe has held up on the strength of yet another disappointing inflation reading for the Eurozone, with CPI in January rising only 1.3%, down from December’s 1.4% reading. At the same time, the unemployment situation in Europe continues to improve, further feeding the conundrum of tightening labor markets and no ensuing inflation. The point is the lack of inflation encourages equity investors to believe that despite the narrative, ECB policy tightening is still a long way off. And this is why there is so much focus on the wage negotiations ongoing in Germany, where the biggest union, IG Metall, is seeking not only a 6% annual wage hike but also additional flexibility for part time workers. Thus far, progress in the negotiations has been slow and starting today there will be one-day strikes across all the regions of Germany by union members, impacting almost every industry. As it is in neither side’s interest for these to be prolonged, I expect a resolution to be agreed soon. And ultimately, it will mean higher wages for German workers. Of course, the key question is will that feed through to the general inflation figures and if so, how long will it take. The obvious connection to the FX market here is that the quicker inflation starts to rise, the quicker the ECB can end QE, which should help further underpin the euro. Certainly, the narrative assumes a direct and rapid response in the inflation data, but we shall see.

However, the euro is not the only currency that has rallied vs. the dollar, it is virtually every other currency that has shown strength this morning. And so, as we have seen for the past week, the driving story remains the dollar itself, not currency specific issues.

Pivoting in that direction shows several key drivers. First, we have seen pretty significant equity market weakness over the past two sessions, with the S&P down more than 2% since Friday. While in the grand scheme of things, that is not very substantial, compared to what we have been witnessing thus far this year (and truthfully all of last year) it is a virtual rout! At the same time Treasury yields have been rising rapidly, reaching their highest levels in nearly four years and showing no signs of stopping. Thus, the question must be asked: Is this the beginning of the end of the rally? It is certainly premature to make that call, but I will say that if we see equities fall further today (futures are currently pointing slightly higher so there is no assurance that will occur), it may be appropriate to label the move the beginning of a trend. How will the dollar behave in this case? My take is that it will initially fall alongside these markets on the belief that investment will flow elsewhere. But if the trend persists and we evolve into a more complete risk-off scenario, I like the dollar to find its footing.

Of course the other story of note today is the FOMC meeting, where the monetary policy statement will be released at 2:00 this afternoon. There is no press conference scheduled and expectations are for no change in policy. In fact, all eyes will be on the wording of the statement for clues as to whether the hawks remain in the ascendancy, or if the doves are regaining ground. If you recall, last meeting there were two dissents to raising rates, Kashkari and Evans, but neither of them is a voting member now as they have rotated away from that role with the changing calendar. This is also Yellen’s last meeting, as her term ends on Sunday and she will be stepping away from the Board completely. As to the wording, while a majority of economists surveyed expect virtually no change to the statement, it is worth watching the description economic activity (currently ‘solid’) and of risks to the economic outlook (currently noted as ‘roughly balanced’ with a chance to be upgraded to ‘balanced’). The inflation wording evokes disappointment but they continue to expect stabilization around 2% over the medium term. Any changes in the inflation outlook will almost certainly impact markets, especially Treasuries, but also stocks and the dollar. In the end, though, there is likely to be little real news from this meeting. March, however, is potentially a different story, with the market pricing in another rate hike and a new Fed chair at the helm.

Finally, we get some more important data today, leading with the ADP Employment report (exp 195K) and then Chicago PMI (64.0). Last month, ADP was quite strong, but the NFP number showed nowhere near the same type of strength. So this month, pundits seem a bit more wary as to its importance. My take is a strong number is likely to be ignored, but a weak one could well push the dollar lower. As to Chicago PMI, it would need to fall a great deal to have any impact. Remember, the market will quickly turn its focus to Friday’s payroll data as well, so this has to be powerful stuff to evoke change.

In the end, the dollar’s recent trend is likely to continue, meaning further modest weakness seems the best bet for now.